Johnsen v. Comm'r of Internal Revenue

Decision Date24 July 1984
Docket NumberDocket No. 12592–80.
Citation83 T.C. No. 8,53 USLW 2450,83 T.C. 103
PartiesJOHN K. JOHNSEN and FRANCES JOHNSEN, Petitioners v. COMMISSIONER OF INTERNAL REVENUE, Respondent
CourtU.S. Tax Court

OPINION TEXT STARTS HERE

L, a limited partnership, was formed in April 1976 to develop an apartment project. P became a limited partner in July 1976. Construction of the project began in Sept. 1976 and was completed in Oct. 1977. During 1976, no tenants moved into the project, and L received no rentals.

Held:

(1) L was not carrying on a trade or business as of Dec. 31, 1976, within the meaning of sec. 162, I.R.C. 1954. Goodwin v. Commissioner, 75 T.C. 424 (1980), affd. without published opinion 691 F.2d 490 (3d Cir. 1982), followed.

(2) P is entitled to deduct his distributive share of the construction loan commitment fee, the $50,000 management and guarantee fee, and a portion of the permanent loan commitment fees incurred during 1976 pursuant to sec. 212(1) or (2), I.R.C. 1954. Hoopengarner v. Commissioner, 80 T.C. 538 (1983), on appeal (9th Cir., Sept. 2, 1983), followed. However, a portion of the permanent loan commitment fee is not ordinary and necessary and is not deductible.

(3) P may not deduct any amount on account of the legal fees and consulting and advisory fees incurred by L during 1976 since he failed to prove that any portion of such fees is properly deductible under sec. 212(3), I.R.C, 1954. Sec. 709(a)1 I.R.C. 1954.

(4) P must adjust his distributive share of partnership items to reflect the fact that he was not a member of L during its entire 1976 taxable year. Sec. 706(c)(2)(B), I.R.C. 1954; Richardson v. Commissioner, 76 T.C. 512 (1981), affd. 693 F.2d 1189 (5th Cir. 1982), followed. Donald W. Geerhart and Donald J. Forman, for the petitioners.

Sara M. Coe, for the respondent.

SIMPSON. Judge:

The Commissioner determined a deficiency of $3,700 in the petitioners' Federal income tax for 1976. After a concession by the petitioner, the issues remaining for decision are: (1) whether a limited partnership formed to develop an apartment project was carrying on a trade or business as of December 31, 1976; (2) if the limited partnership was not carrying on a trade or business during 1976, whether the petitioner may deduct under section 212(1) or (2) of the Internal Revenue Code of 19541 his share of loan commitment fees and management and guarantee fees incurred by the limited partnership in 1976; (3) whether the petitioner may deduct under section 212(3) his share of the legal fees and consulting and advisory fees that the limited partnership incurred in 1976; and (4) whether the petitioner's distributive share of the limited partnership's expense items should be adjusted to reflect the fact that the petitioner was not a member of the partnership during its entire 1976 taxable year.

FINDINGS OF FACT

Some of the facts have been stipulated, and those facts are so found.

The petitioners, John K. and Frances Johnsen, are husband and wife who maintained their legal residence in West Bloomfield, Mich., at the time they filed their petition. For their 1976 taxable year, they filed a joint Federal income tax return with the Internal Revenue Service Center, Cincinnati, Ohio. Mr. Johnsen will sometimes be referred to as the petitioner.

In 1969, Charles W. Greener and Alan R. Sumner formed the architectural firm of Greener & Sumner Architects, Inc., and during 1976, they owned between 80 and 85 percent of the stock of such corporation. Since the early 1970s, Mr. Greener and Mr. Sumner engaged in the development of real property located in the South and Southwest. They conducted their development activities through a general partnership, which was their primary development company, as well as through the architectural corporation, a construction corporation, and Centre Property Management (CPM), which managed the projects in which they were involved.

Mr. Greener and Mr. Sumner were involved in the development of the Centre Square project, consisting of two apartment projects and a tennis club, located on contiguous parcels of land in Richardson, Tex. The plan for the entire complex was conceived in 1972, but the complex was built in stages. The tennis club was constructed first, and the Centre Square I apartment project was completed next in late 1974 or early 1975. Construction of Centre Square III, the second project, was deliberately delayed to avoid over-building the market.

On April 11, 1976, Mr. Greener, Mr. Sumner, Robert S. Spencer, Ralph P. Lebkuecher, Ralph E. Noble, and W. W. Harlan formed Centre Square III (the general partnership). The partnership agreement was subsequently amended, retroactive to April 11, 1976, by eliminating Mr. Noble and Mr. Harlan as general partners. Centre Square III, Ltd. (the limited partnership), was also formed on April 11, 1976. The limited partnership utilized the accrual method of accounting. The general partners of the limited partnership were Norman L. Nelson, Jr., Greener & Sumner Architects, Inc., and Equity Advisors, Inc. During 1976, Mr. Lebkuecher and Mr. Spencer each owned 50 percent of the stock of Equity Advisors, Inc. The original limited partner of the limited partnership was Dee W. Dilts, who was Mr. Nelson's law partner.

The parties to the limited partnership agreement intended Mr. Dilts to be a nominee who would have no interest in Centre Square III and who would withdraw when the new limited partners were admitted. By an amended limited partnership agreement, effective September 9, 1976, Mr. Dilts withdrew as original limited partner and was replaced by 22 other limited partners (counting each husband and wife couple as one limited partner) including the petitioner, each of whom had executed the amended limited partnership agreement between May and September 1976.

The original limited partnership agreement provided that the limited partners would have a 99-percent interest in the capital and profits of the limited partnership through December 31, 1980; thereafter, the limited and the general partners would each have a 50-percent interest in the limited partnership's capital and profits. The limited partnership agreement also provided that from April 11, 1976, through December 31, 1980, the general partners would guarantee a cash flow sufficient to provide a break even operation on a cash flow basis; i.e., the general partners agreed to pay any cash flow deficits in the event the partnership failed to break even. The “no negative cash flow” guarantee was customary in the syndication of similar projects, and the guarantee made limited partnership interests much more marketable.

On April 11, 1976, the general partnership agreed to sell its entire interest in the Centre Square III apartment project, including the land, plans, specifications, and any contracts concerning the project to the limited partnership, for $3,171,200. On the same day, the limited partnership executed a written management agreement with the general partnership. Under the terms of the agreement, the general partnership assumed total responsibility for the leasing, management, and administration of Centre Square III. The general partnership was responsible for the selection, training, supervision, and scheduling of the work of all the necessary personnel and consultants. The agreement provided that the general partnership could utilize others to discharge its duties, although it remained ultimately responsible for performance. The general partnership was also obligated to make all reasonable efforts to promptly lease all the units in Centre Square III. The management agreement specified that as soon after the commencement of construction as was practicable, the general partnership would begin an aggressive campaign of advertising and promotion so that units would be rented as they were completed. Such agreement specified that the general partnership would bear the costs of the campaign. The general partnership again guaranteed that Centre Square III would operate without cash flow deficits through December 31, 1980. Finally, the management agreement provided that the general partnership would receive management and guarantee fees of 5 percent of the gross receipts generated by Centre Square and an additional $50,000 each year for 1976 through 1980. During 1976, there were no gross receipts, and the percentage fee yielded no payment. In that year, the fixed fee was primarily intended to compensate the general partnership for management activities; after 1976, the percentage fee was allocable to management activities, and the fixed fee was allocable to the cash flow guarantee.

On April 13 and April 26, 1976, Mr. Greener personally acquired title to the land upon which Centre Square III was to be built by four separate warranty deeds. The approximate cost of all the land was $455,000; the purchase price was financed by a loan in the amount of $450,000 from the Mercantile National Bank. On September 9, 1976, Mr. Greener executed a deed conveying the land to the general partnership for $450,000, and such deed was filed for recording the next day. On September 10, 1976, the general partnership executed a deed conveying the Centre Square III land to the limited partnership, but such deed was not recorded.

Sometime between August 5, 1976, and September 9, 1976, the general partnership secured a commitment from Wells Fargo Realty Advisors Incorporated (Wells Fargo) for a construction loan in an amount not to exceed $2,820,000. On September 9, 1976, the general partnership paid a commitment fee to Wells Fargo of $28,200. Pursuant to the commitment, Wells Fargo and the general partnership entered into a building loan agreement on September 9, 1976, and the partnership issued a promissory note for $2,820,000 to Wells Fargo signed by the six partners. The general partners individually guaranteed the note because Wells Fargo required the individual guarantees as a condition of its commitment. The...

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